Tuesday, 17 July 2018

SNB: NIRP is now key policy instrument

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Divyang Shah on the implications of the shock Swiss decision.

The search is on for answers as to why the SNB choose to abandon the EUR/CHF floor even before negative interest rates had the chance to come into effect next week.

We think that the SNB would still be happy playing its old EUR/CHF floor/negative rates script but were forced to adopt a new script of no floor, FX intervention and more negative rates due to the high probability of ECB QE next week.

Remember that negative interest rates were not supposed to come into effect until the ECB meeting on Jan 22, so the SNB’s actions had been directed at limiting the impact of further ECB easing.

The SNB statement says that it expects divergences between the monetary policies of the major currency areas to “become even more pronounced”, leading it to conclude that “enforcing and maintaining” the EUR/CHF floor was no longer justified.

Instead of a defensive and passive policy of the EUR/CHF floor, the SNB has switched to a more aggressive stance by abandoning the floor and fighting safe-haven flows with negative interest rates.

Continuing with the floor would have forced the SNB to implicitly engage in a more aggressive expansion of its balance sheet, via FX intervention, to mop up ECB QE-related liquidity.

Even with a deposit rate of -0.75%, we do not think the CHF is unattractive enough to prevent further appreciation. We should expect the SNB to conduct smart FX intervention but, more importantly, rely on NIRP (negative interest rate policy). Further rate cuts from the SNB will likely happen sooner rather than later as the SNB looks to make this the key policy instrument.

The market implications of the SNB’s actions are:

1) it’s another reminder that investors need to be cognisant of the dangers of illiquidity risk and one-way market positioning

2) the SNB is not alone in feeling the impact of ECB QE, with the Riksbank likely going to NIRP from the current ZIRP and the Norges Bank likely cutting 50pbs at their next meetings

3) a less aggressive SNB hovering up EUR’s means potentially greater downside on EUR/USD.

The above helps to cement our existing suggestions of receiving 1-yr/2-yr SEK and 1-yr/1-yr NOK on rates, as well as very OTM EUR puts/USD calls in FX. A long vol bias on the portfolio also makes sense.

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